Monday, January 26, 2009

Jeremy Grantham Quarterly Letter

In October last year perennial bear Jeremy Grantham, chairman of Boston-based GMO, said: “We are reconciled to buying too soon, but we recognize that our fair value estimate of 975 on the S&P 500 is, from historical precedent, likely to overrun on the downside by 20% to 40%, giving a range of 585 to 780 on the S&P as a probable low.

“The world faces unavoidable declines in economic activity and profit margins, so this overrun is unlikely to be much less painful than average, although you never know your luck.”

Given Grantham’s forecast, it was with keen interest that I have been awaiting his latest quarterly newsletter entitled “Obama and the Teflon Men, and Other Short Stories. Part 1“. The following paragraphs are a summary of his investment recommendations from this report:
“The current disaster would have been easy to avoid by making a move against asset bubbles early in their lifecycle. It will, in contrast, be devilishly hard to get out of. But, we are deep in the pickle jar, and it seems likely that, in terms of economic pain, 2009 will be the worst year in the lives of the majority of Americans, Brits, and others. So break a leg, everyone!

“Slowly and carefully invest your cash reserves into global equities, preferring high quality US blue chips and emerging market equities. Imputed 7-year returns are moderately above normal and much above the average of the last 15 years. But be prepared for a decline to new lows this year or next, for that would be the most likely historical pattern, as markets love to overcorrect on the downside after major bubbles. 600 or below on the S&P 500 would be a more typical low than the 750 we reached for one day.

“In fixed income, risk finally seems to be attractively priced, in that most risk spreads seem attractively wide. Long government bond rates, though, seem much too low. They reflect the short-term fears of economic weakness and the need for low short-term rates. We would be short long government bonds in appropriate accounts.

“As for commodities, who knows? There were a few months where they looked like a high-confidence short, but now they are half-price or less, and are much lower confidence bets.
“In currencies, we know even less. It is easy to find currencies to dislike, and hard to find ones to like. There are no high-confidence bets, in our opinion.

“For the long term, research should be directed into portfolios that would resist both inflationary problems and potential dollar weakness. These are the two serious problems that we may have to face as a consequence of flooding the global financial system with government bailouts and government debt.”

Click here for the full report on Grantham’s views.

Wednesday, January 21, 2009

Bank Shrinkage - Nothing to See Here - Move Along

I recall attending a seminar in 2007 and Citigroup was recommended as a buy. Glad I didn't listen.

Saturday, January 17, 2009

S&P 500 Valuation Hits 18-Year Low

From Bloomberg.

By Eric Martin

Jan. 16 (Bloomberg) -- U.S. stocks gained for a second day as investors snapped up shares trading at the cheapest levels in 18 years and concern eased that more banks will fail.

The Standard & Poor’s 500 Index recovered from a drop of 1.6 percent after its valuation slid to 14.8 times reported earnings, the lowest since 1991. Intel Corp. climbed 3.4 percent on its prediction that profitability may improve next quarter. Bank of America tumbled 14 percent even after getting a $138 billion federal lifeline. Shares rallied in the final hour after Bill Gross, manager of the world’s largest bond fund, said the worst of the credit crisis may be over, according to Reuters.

“Nobody is really willing to step up for risk today; for the thinking investor, there’s a lot of opportunity because of that,” said Robert Lutts, president of Cabot Money Management, which oversees $400 million in Boston. “When the opportunities are there, it often doesn’t look pretty.”

The S&P 500 added 0.8 percent to 850.12 and trimmed its decline over the past five days to 4.5 percent, its worst week since November. The Dow Jones Industrial Average rose 68.73 points, or 0.8 percent, to 8,281.22. The KBW Bank Index of 24 lenders sank 4.1 percent to below its lowest closing level since June 1995.

U.S. stock-index futures and European shares rallied in early trading after the government agreed to invest $20 billion more in Bank of America and guarantee $118 billion in assets to help the lender absorb Merrill Lynch & Co. The market fluctuated in early afternoon trading as financial shares in the S&P 500 reversed course and fell 2.4 percent collectively.

Profitability Rebound

Intel Corp. helped lead gains after the world’s biggest maker of semiconductors said profitability may rebound following the first quarter, when customers finish working through excess supplies. The company said revenuethis quarter may be about $7 billion, without providing an official forecast. Intel climbed 45 cents to $13.74.

Technology shares in the S&P 500 climbed 1 percent collectively and contributed the most to the market’s advance.

Bank of America tumbled $1.14 to $7.18, an 18-year low, after earlier rallying as much as $1 to $9.32. The largest U.S. bank by assets also posted its first loss since 1991 and cut its quarterly dividend to 1 cent a share from 32 cents.

‘Bottom of the Capital Structure’

“Today’s action in the banks and the government’s actions to help them is making it clearly evident that what is good for their viability and bondholders will not square with the interests of equity holders at the bottom of the capital structure,” Peter Boockvar, equity strategist at Miller Tabak & Co., said in a note to clients.

First Horizon National Corp., Tennessee’s biggest bank, climbed 18 percent, the steepest gain in the S&P 500, to $8.82 after it posted a fourth-quarter net loss that was narrower than analysts projected.

Citigroup Inc. slipped 8.6 percent to $3.50 after earlier climbing to as high as $4.48. The bank posted an $8.29 billion fourth-quarter loss, completing its worst year, as the credit crisis eroded mortgage-bond prices and customers missed more loan payments.

Citigroup, which earlier this week said it will sell control of the Smith Barney brokerage to Morgan Stanley, plans to undo the legacy of former CEO Sanford “Sandy” Weill by splitting into two companies. Citicorp will house the New York- based company’s global bank, while Citi Holdings will hold “non-core” assets, including $301 billion of mortgages, bonds, corporate loans and other assets that the government agreed in November to guarantee.

Citigroup extended its loss this week to 48 percent, while Bank of America lost 45 percent.

‘Fool’s Game’

“Investing in the common stock of a large bank today is a fool’s game because they can’t grow,” said Malcolm Polley, chief investment officer of Stewart Capital Advisors LLC, which manages $1 billion in Indiana, Pennsylvania. “The game everyone’s playing now is: how small will these banks get?”

Energy stocks in the S&P 500 climbed 1.2 percent collectively after oil for February delivery rose $1.16, or 3.3 percent, to $36.56 a barrel as traders purchased contracts in an attempt to profit from higher prices in future months.

Tesoro Corp., the largest oil refiner in the U.S. West, led gains among energy stocks, climbing $1.48, or 10 percent, to $15.91. Sunoco Inc., the largest oil refiner in the U.S. East, increased $2.41, or 6 percent, to $42.31.

The gains in stocks today came despite economic data that signaled the recession deepened last month.

Manufacturing Slump

Output at factories, mines and utilities dropped 2 percent last month after a revised decline of 1.3 percent in November that was more than double the previously reported decrease, the Federal Reserve said today in Washington. Plant use matched the lowest level since 1983.

The cost of living fell in December, capping the smallest annual gain in a half century. Consumer prices fell 0.7 percent in December after dropping 1.7 percent the prior month. Excluding food and energy, costs were unchanged. Americans paid 0.1 percent more for goods and services in 2008, the least since 1954, the Labor Department said.

The 5.8 percent slide in the S&P 500 so far this year suggests the so-called January barometer will signal a loss for 2009. The indicator was developed byYale Hirsch, chairman and founder of the Stock Traders’ Almanac, and built on the theory that the S&P 500’s first-month performance sets its course for the year.

‘January Barometer’

Since 1950, the barometer has been at least 80 percent accurate. One of the exceptions occurred in 1978, when the index rebounded from a January drop of 6.2 percent to close 1.1 percent higher.

The S&P 500 reached an 11-year low of 752.44 and the Dow slid to the lowest since 2003 on Nov. 20. Stocks tumbled as more than $1 trillion in bank losses froze lending and spurred a global recession.

A decline in U.S. stock indexes below the 2008 lows from November may trigger a rout that pushes benchmark averages to levels not seen since the mid-1990s, according to technical analysts Ralph Acampora and John Murphy. Should the Dow fall below the 7,552.29 it touched on Nov. 20, it might tumble to 6,000, according to Acampora, who retired from Knight Capital Group Inc. in October 2007 after four decades on Wall Street.

Estee Lauder Cos. dropped 10 percent to $26.11, the steepest decline in the S&P 500 after Bank of America. The maker of Clinique and Bobbi Browncosmetics cut its sales and profit forecast for fiscal 2009 ending June 30, citing “deteriorated global economic conditions.”

“Valuations are pretty good, but people are going to wait for earnings to come through,” said Frank Ingarra, a manager at Novato, California-based Hennessy Advisors Inc. who helps oversee the $177 million Hennessy Focus 30 Fund that beat 95 percent of its peers last year. “The last few days have felt like we were back in October again: No end in sight, everyone’s going to die, it’s going to be awful. Hopefully we’re getting some semblance of calm.”

To contact the reporter on this story: Eric Martin in New York

Wednesday, January 14, 2009

Tuesday, January 13, 2009

Investing is Tricksy

"Many people cling to flawed intuitive models to explain how or why events occur. For example, if a coin is tossed six times and its result – heads (H) or tails (T) – is recorded, the outcomes T-T-HT-H-H and T-T-T-H-H-H are equally probable.

However, many people believe the first pattern is more likely to occur. To them, it just seems more probable. They may have no evidence to support this belief. It just feels right. Some will attempt to find a repeating or causal pattern in the second series, even though there is no real reason to believe one exists.

This type of cognitive error—seeing a pattern or predictability in random events—is so common and so imbedded in stock market analysis that we practically take it for granted. For instance, market analysts are notorious for projecting historical trends too far into the future. They project sales, earnings, stock prices, and many other statistics for years or decades despite evidence that these quantities are inherently difficult to predict.

In addition, a study shows Wall Street analysts have strong financial incentives to be overly optimistic. Research by Harrison Hong, an associate professor at Stanford Business School, and Jeffrey Kubik of Syracuse University found that analysts who deliver optimistic earnings forecasts (not necessarily accurate forecasts) are more likely to be promoted.

Results of the professors’ study, titled “Analyzing the Analysts: Career Concerns and Biased Earnings Forecasts,” were reported in The Financial Times in February 2002. In predicting the future growth of rapidly expanding companies, their expectations are often tied to the recent past even though growth rates usually revert toward an average.

In most cases, there is no real evidence that extending the past trend will be any more accurate than predicting in accordance with broad averages, and yet investors act on extrapolations as if they were probable events. Such “faulty intuition” can set the stage for overconfidence and subsequent overreaction. For example, an inaccurate model of a company’s business prospects can cause portfolio managers to believe double digit earnings growth will continue for decades, even though such cases are extremely rare. The Internet stock bubble in the late ‘90s was a good example.

Overconfidence in intuitive models can also cause investors to miss opportunities. For example, an incorrect model might lead to the belief that a poor-performing business will never recover, causing invest ors to miss a good buying opportunity. In the late 1970s and early 1980s, expectations of continued “stagflation” led to a general negative overreaction on the part of equity investors. The resulting low stock prices prompted Business Week magazine to proclaim the “Death of Equities” in a cover story published in August 1982. As it turned out, this date coincided with the beginning of the greatest bull market in the history of U.S. stocks.

Value investors recognize tendencies such as “faulty intuition” and establish pre-determined processes based on objective analysis rather than personal preference or out-of-context judgments to guide their investment decisions."

Monday, January 12, 2009

Jobs Will Disappear

This is a rosy outlook. Unfortunately, I think they have underestimated the potential job losses or are using a 'best case scenario' - I could see BC shedding up to 80,000 jobs during 2009. Check out this rosy report from May 2008.

The chief economist of B.C.’s Central 1 Credit Union expects employment in B.C. to drop two per cent in 2009, a decline of about 40,000 jobs as the world’s economic turmoil continues.Jobs in construction and retail trades will be the hardest hit, Helmut Pastrick said Thursday. “The downturn in the housing market is leading to a sharp fall in housing construction this year,” Pastrick said.“We’re seeing some slowdown in non-residential construction that’s already begun to play out.”Other job loses will be broad-based, he said, and affect most private-sector industries. Public-sector and government-funded jobs in fields like health care and education should hold strong and may even post some gains.Statistics Canada releases its monthly labour force survey Friday. Job losses in December are expected to be between 20,000 and 50,000 across the country. In November, Canada had 71,000 net job losses.This year, Pastrick said he expects a “substantial increase in unemployment” and anticipates B.C.’s unemployment rate rising to seven per cent, up from 4.9 per cent in November. He expects things will turn around — probably —by 2010. “It depends on the global economic recession, how soon it ends and the strength of the recovery. Fortunately in 2010 … we have the Winter Olympics that may provide a nice boost, albeit temporary.”

Saturday, January 10, 2009

Thursday, January 8, 2009

Byron Wien Announces Ten Surprises for 2009

WESTPORT, Conn.--(BUSINESS WIRE)--Byron R. Wien, Chief Investment Strategist of Pequot Capital Management, Inc., today issued his list of Ten Surprises for 2009. Mr. Wien has issued his economic, financial market and political surprises annually since 1986. The 2009 list follows:

1. The Standard and Poor’s 500 rises to 1200. In anticipation of a second-half recovery in the U.S. economy, the market improves from a base of investor despondency and hedge fund and mutual fund withdrawals. The mantra changes from “fortunes have been lost” to “fortunes can still be made.” Higher quality corporate bonds, leveraged loans and mortgages lead the way.

2. Gold rises to $1,200 per ounce. Heavy buying by Middle Eastern investors and a worldwide disenchantment with paper currencies drive the price of precious metals higher. In a time of uncertainty, investors want something they can count on as real.

3. The price of oil returns to $80 per barrel. Production disappointments and rising Asian demand create an unfavorable supply/demand balance. Other commodities also rise, some doubling from their 2008 lows. Natural gas goes to $9 per mcf.

4. Low Treasury interest rates coupled with huge borrowing by the Treasury send the dollar into a serious downward slide. Overseas investors become concerned that the currency printing presses will never stop. The yen goes to 75 and the euro to 1.65.

5. The ten-year U.S. Treasury yield climbs to 4%. Later in the year, as the economy shows signs of recovery, economists and investors shift their mood from concern about deflation to worries about inflation. A weak dollar, rapid growth in money supply and record-setting deficits (over $1 trillion) are behind the change.

6. China’s growth exceeds 7% and its stock market revives. World leaders credit China’s authoritarian government for its thoughtful stimulus policies and effective execution during a challenging period. The Chinese consumer begins to spend more and save less and this shift is behind the unexpected strength in the economy.

7. Falling tax revenues from the financial sector cause New York State to threaten bankruptcy and other states and municipalities follow. The Federal government is forced to step in and provide substantial assistance. The New York Post screams “When will the bailouts stop?”

8. Housing starts reach bottom ahead of schedule in the fall, and house prices stabilize after dropping 15% from year-end 2008 levels. The Obama stimulus program proves effective and a slow growth recovery begins before year-end. Third and fourth quarter real gross domestic product numbers are positive.

9. The savings rate in the United States fails to improve beyond 3%, as most economists expect. The concept of thrift seems to have vanished from American culture. Peak job insecurity and negative growth drive increased savings early in the year, but spending resumes as the economic growth turns positive in the second half, making Christmas 2009 the best ever.

10. Citing concerns about Iraq’s fragile democratically elected government and the danger of a Taliban-controlled Afghanistan, Barack Obama slows his plan for troop withdrawal in the former and meaningfully increases U.S. military presence in the latter. In a hawkish speech he states that the threat of terrorism forces the United States to maintain a strong military force in this strategic area.

Mr. Wien believes these surprises, which the consensus would assign only a one-in-three chance of happening, have at least a 50% probability of occurring at some point during the year. In previous years, more than half of the elements of the list have proven correct.

Sunday, January 4, 2009

2009 Family Budget

It was time for annual family meeting to discuss the budget for the upcoming year.  Click on the chart above to enlarge.  Every year since we've been married, my lovely wife and I discuss our annual goals and limits on our spending for a few hours on New Years Day.  This is the result of this year's meeting.

Some notable changes for this year is the aggressive mortgage paydown strategy.  We currently have a fixed rate mortgage for the next 4.5 years with fairly liberal repayment terms and our goal is to have the mortgage paid down to a level that could see us having it paid completely off through the following five year term.  In fact, if my pay rises and no unforeseen events occur, we could easily pay of the mortgage over a total of 6 years thus allowing us the freedom to use the cash flow for other purposes.  This is extremely ambitious and probably unrealistic but it is something we have set our sights on.

We are attempting to strike a balance between an ambitious RRSP contribution strategy and our aggressive mortgage paydown plan.  We also have allowed for some large one time purchases like a new television and some new furniture.  

Regarding our balance sheet, we expect that the value of our investments will not rise this year and we have planned that the value of our home will fall by 10% or more this year.  We bought it at 20% off peak pricing and I expect it will fall another 10% or more during 2010.  We have an extremely long time horizon (20+ years) for our investments so I am not concerned about the short term value of my retirement savings.

We have also increased our allotment to 'life and health insurance' and 'food and consumables' to account for our increased needs this year with an additional child coming.

Any comments?